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Freshfields Risk & Compliance

| 3 minutes read

Part 1: The Ukraine crisis - implications for UK pension schemes from an ESG perspective, their employers and social investment

The invasion of Ukraine by Russia, and the wide-ranging sanctions subsequently imposed by the international community, have led to volatility in financial markets. In this article we consider the immediate effect of the Ukraine crisis for trustees of pension schemes from an ESG perspective.

The Ukraine crisis as a financially material factor

The invasion of Ukraine prompted a large scale exodus of foreign investment from Russia. A number of pension schemes and investment companies have either exited the Russian market completely or announced that they intend to divest of their Russian assets when appropriate to do so. In response, the UK Pensions Regulator (the Regulator) has issued guidance for schemes to address the situation.

The Regulator has discouraged trustees from making any hasty investment decisions, advising them instead to prioritise their fiduciary duties. Before acting, trustees should also consider whether their decision is in line with the investment strategy contained in their scheme’s Statement of Investment Principles (SIP). This includes considering whether the step to remove or reduce investments connected with Russia is motivated by “financially material” factors.

The financial and social implications of the Ukraine crisis are very clearly linked in this context. The potential for overlap between financial and social factors is recognised in UK legislation - the Occupational Pension Schemes (Investment) Regulations 2005 (the Regulations) provide that “financially material” considerations include “environmental, social and governance considerations (including but not limited to climate change) which the trustees of the trust consider financially material”. Such financial considerations will be highly persuasive when justifying a decision to divest of Russian assets - the collapse of Russian assets and the legal requirement to comply with sanctions certainly is a “financially material” factor.

The Regulator does however remind trustees that financially material factors should be considered against the “appropriate time horizon” for the scheme and its members. Given the long-term nature of pension schemes, some trustees might choose to ride out short-term volatility rather than making a quick decision.

Any decision will likely depend on the size of the scheme’s exposure to Russia. Recent reports suggest that for most schemes, exposure to Russia is fairly minimal. For example, only 0.5 per cent of the Universities Superannuation Scheme’s (USS) £90 billion portfolio are connected to Russia (see the USS announcement here). Nevertheless, it will be important for trustees to ask their investment managers how investments in Russia or in foreign companies that have operations in Russia might affect their scheme.

What role do social factors play?

Some of the largest UK pensions schemes have reacted to the Ukraine crisis by attempting to minimise or remove their investments in Russia. For example:

  • NEST announced its decision to remove all its investments in Russian government bonds and Russian companies (here).
  • The Transport for London Pension Fund has frozen all existing direct holdings in Russian-domiciled investments (here).
  • The USS is currently selling its Russian assets and has approximately halved its equity investments in Russia (here).

In announcing its decision, the USS Scheme noted that there was both a financial and a moral case for divestment in Russian holdings. This begs a question - just how much of a role can social and moral considerations play in investment decisions?

As noted above, the law provides some scope for considering non-financial factors. According to the Regulations, non-financial factors include “the views of members and beneficiaries including (but not limited to) their ethical views and their views in relation to social and environmental impact and present and future quality of life”.

In 2014 the Law Commission identified a two-stage test that would need to be satisfied before trustees took non-financial factors into account. The two limbs of the test are:

  • trustees should have good reason to think scheme members hold the concern; and
  • the decision should not involve a significant financial detriment.

When it comes to the Ukraine crisis, the ethics of withdrawing from Russia seem to dovetail conveniently with the financial reasons – Russian assets are likely to depreciate in value, and even if they don’t, direct exposure of pension schemes to Russian assets is reportedly minimal, so withdrawing out of Russia is unlikely to cause significant financial detriment. There are also good reasons to think pension scheme members hold a view that their pension savings should not currently be connected to Russia in so far as is possible.

This might not be as clear for other issues such as fossil fuel divestment or investment in countries with contestable democratic credentials or human rights records. Situations like the current war in Ukraine, however, are an opportunity for trustees to consider how existing investments with potentially harmful associations could be problematic in the future.

What about scheme employers?

The Ukraine crisis is an example of the social factors that will impact the ESG agenda of a sponsoring scheme employer. This will be covered in a separate blog which explains why a sponsoring employer should consider the “S” of ESG before employees and shareholders begin to ask them difficult questions.


pensions, esg